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What You Should Know Before Becoming a Landlord

Geoff Williams
RICHMOND, CA - JUNE 15: A "for rent" sign is posted in front of a house on June 15, 2012 in Richmond, California. According to a report by Harvard University's Joint Center for Housing Studies, the tepid real estate market could see a turnaround with the price of rental properties surging and vacancies dropping from 10.6 percent in 2009 to 9.5 percent last year, the lowest level since 2002. (Photo by Justin Sullivan/Getty Images)

Brian Carmen didn't set out to be a landlord. He still doesn't aspire to be one. It's a part-time gig. Full-time, he is a cyber security consultant.

But like many accidental landlords, Carmen, who lives in Baltimore, began construction on a new house about the time he realized that selling his old one wasn't going to be very profitable.

"We quickly realized that in the market today, with what we still owed, if we were lucky, we'd end up walking away from the table with a couple grand in our pockets," Carmen says, adding that the profit wouldn't even cover the down payment on the new house. So Carmen and his wife, Missi, decided to rent out their first house.

They listed the property on Craigslist, and within hours Carmen received a call from a young woman who was interested. She, along with two friends, became the Carmens' tenants on Oct. 1, paying $2,250 in total monthly rent. The three young professionals all have exceptional credit scores, Carmen says, and it's only been about a month, but everything has gone just the way he had hoped.

[Read: 5 Steps to Renting Out Your Home.]

But not every landlord is so lucky. Some see red flags the day tenants move in. When Aimee Elizabeth, a 50-year-old Las Vegas business consultant, first rented out her home 15 years ago, she discovered her tenants were stealing electricity from a neighbor's house. Later, the tenants were caught stealing electricity, gas and water from the utility companies.

"Not only did I have to pay thousands to the various utility companies to put the meters back on, but I had to have an electrician redo the entire wiring and breaker box, and have it re-inspected by the county before I could get a new electric meter installed," Elizabeth says. After the tenants were evicted, she discovered they had destroyed the meter in their efforts to steal electricity.

"I'm lucky my entire house didn't burn down," says Elizabeth, who now rents out three condos and 18 single-family homes.

So if you're planning to channel your inner Mr. Roper and would rather have an experience more like Carmen's than Elizabeth's, here are a few things - of many - to consider.

Get a background check for any prospective tenant. You'll typically spend between $20 and $30, but the cost far outweighs the risk of landing a bad tenant. Jay Malik, a business accountant and tax coach who advises doctors and dentists, says one reason you want to look at a tenant's history is to see if he or she has been evicted. Some tenants have made getting free rent something of an art, according to Malik, who says many of his physician and dentist clients became accidental landlords when the recession was riding high.

"In most areas, it takes a couple of months to evict a tenant through the local court process. Bad tenants know this," Malik says. He explains the process this way: The tenant gives a sob story about why the rent is late, and "after a few months, the landlord realizes that he is being played, so he files for eviction."

It may take a couple more months before the court date is set. Once the court orders eviction, the tenant finally leaves - many months of having lived rent-free.

Familiarize yourself with the laws involving landlords and tenants. Every state is different and, generally, you'll find a dizzying array of regulations. You can get started learning some of them by searching online for your state and the words "tenant," "landlord" and "laws." You should find a state government website that outlines the laws and rules you need to be aware of.

"Virtually all laws regarding landlord-tenant issues heavily favor the tenant, and if you - almost literally - forget to dot an 'i,' you can be eviscerated in court," warns Allen Morris, a real estate broker and owner of North Bloomfield Properties, based in West Bloomfield Township, Mich.

[Read: 3 Money Mistakes That Will Come Back to Haunt You.]

An example Morris cites for his state: "If you neglect to have a tenant fill out a lead paint disclosure and [forget to] give them the required HUD booklet, you just committed a felony punishable by two years in prison."

Consider that you may have to fix things. That's why some homeowners hire companies like North Bloomfield Properties to serve as landlord. Costs are usually around 10 percent of the monthly rent, give or take a few percentage points. Property management companies handle the tasks that some homeowners dread, like collecting rent and making repairs.

If you want to manage your property but aren't a handyman, you could purchase a home warranty that covers major repairs and appliances, suggests Carmen, who says his costs are about $400 annually.

"I've included in the lease a stipulation that any time we need to use the warranty, the lessees and I will split that deductible. It gives them a little skin in the game, so to speak," Carmen says. It's also a fairly common practice when renting single homes.

Set ground rules. Bruce Specter, a loan consultant, has owned multiple houses, first in Scottsdale, Ariz., and now Reno, Nev. He suggests limiting the amount of people who can live in your house - and their vehicles.

For example, he says a woman with children moved into one of his properties. "Next thing you know, the boyfriend moves in with his kids and his hobby of restoring junk cars. Next thing you know, we have an episode of 'The Brady Bunch' meets 'Sanford & Son,'" he says.

On the plus side, Specter says, when the tenants moved out, they left the place spotless. Many tenants won't, however, which is why security deposits are such a good idea. Morris says he visited a house he had rented after the tenants moved out and found a pig in one of the bedrooms, which was also full of straw, mud and pig droppings. "You've heard of a house being a pig sty? Well, this place literally was a pig sty," Morris says.

Make sure your homeowner's insurance covers your tenants. "The worst possible scenario is that someone is injured on your property and sues the landlord, and the insurance company denies coverage," says Richard Ernsberger, a Pittsburgh real estate attorney.

[See: 10 Costs Homeowners Insurance Doesn't Always Cover.]

Be realistic. These days, few tenants will have perfect credit, and looking for someone with a score in the 700s may mean keeping your home empty for a long time.

Besides, "credit isn't the most important issue," Specter says. "It's the rental history and job stability."

And if someone waves a lot of cash in front of you, that's not always a good sign. "Still vet them," urges Specter, who has had two tenants offer six months' rent upfront in cash.

He turned both down, which may have been a good call. A tenant who only pays in cash may not have a bank account, which could mean he or she has money problems - or worse.

One of Malik's clients rented out a house out to a "nice family with little kids." The tenants turned out to be drug dealers, and always paid their rent in cash. "Mostly in $20 bills," Malik says. "It never occurred to her to be suspicious of this arrangement."

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